Friday, November 13, 2009

Some folks are still asking about the justification of different prices for health care services paid by different groups of people. The tone of the critiques is that the well-to-do are supporting a system that benefits them at the expense of the people who pay full prices for doctor and hospital services -- with those latter people being to a great extent the uninsured.

First, let's see if we can get some data to bear on the problem, rather than relying on my speculations and the media's love for heart-wrenching anecdotes. We can always find, for any system, some stories that make us want to cry, like the uninsured person who goes bankrupt because of a huge hospital bill based on full prices. I don't want to completely dismiss the exceptional cases, but I think when we are designing a social/economic policy we should focus on the total picture.

So I had speculated that not too many people pay full price at hospitals, and I claimed that many hospitals treat the destitute for free. In fact, most hospitals have formal sliding scales of prices, giving LOWER prices to lower income people. I found a good blog posting by Uwe Reinhardt at Princeton on this subject, and he referenced a paper, Melnick and Fonkych, "Hospital Pricing and the Uninsured: Do the Uninsured Pay Higher Prices?" in Health Affairs, Feb. 5 2008. The Reinhardt piece is very good; he actually argues for a law that would restrict pricing to the uninsured at more than 115% of Medicare rates -- although he also admits that for most hospitals this would be nonbinding, as they already do so.

But on to the main article and their findings. They looked at California hospitals in 2005-2007. Below is the chart of their main findings:

So what does this show? Well, the four solid lines show the percent of full price paid by four groups of patients: The commercially insured; the uninsured; Medicare; and MediCal (low income California Medicaid system). You can see a few things. First, who pays the most? The insured. Of course. Who pays the least? MediCal, followed closely by Medicare. Just for the record, Medicare patients in 2005 paid on average about 27% of full price!!! Even the insured, who pay the most, only pay about 38% of full price.

Point number one: my claim that not many people pay full price is correct. Given how low all of these percentages are, there is no statistical way that many people can be paying full price. Some in the sample will be, no doubt, but to get an average of 27% I am sure that the vast majority are paying closer to 27% than to 100%.

Point number two: Who pays on average the most? The insured population. Again, of course. If anything, the insured patients should be screaming about the lower prices being given to the Medicare, Medicaid, and uninsured populations. (But be careful here: it is probably profitable for the hospitals to charge lower prices to those groups -- that is what price discrimination is all about. Prices to the insured would be even higher if the hospitals had to cover all their costs just from the insured population.)

Point number three: Who pays the least? Those insured through government programs, that is, Medicare and Medicaid. So those of you out there who want "one price to all" better realize that the biggest effect of that will be to raise Medicare costs substantially. Essentially what we have here is a hidden tax: the government uses their negotiating clout with doctors and hospitals to get lower rates, which the rest of us then pay for. If you mandate one price, then Medicare will have to raise funds somehow else -- an increase in the income tax, most likely.

Point number four: This pricing is pretty crazy, with list prices being so high. Why not just cut them down across the board? I could go into that, but it is not crucial right here and now.

Beyond this paper, another main point of mine about price differences for health care is that they serve a very important purpose. If the government mandates one price for all, how is that one price ever going to be determined in anything that would approach a competitive fashion? It is the ability for one buyer to negotiate and get a better rate for themselves that benefits all of us by helping to set prices at a reasonable level and keep the escalation of health care costs to a lower level.

Also, people have this idea that pricing is kind of a zero sum game. If one group gets a lower price, someone else has to get a higher price. That logic is tempting but not correct. Hospitals have huge fixed costs they need to cover, from all groups. If you don't let the commercial insurance group get a lower price, you won't get their business. Then all of the fixed costs need to be covered by the remaining groups -- the self insured, for example. The price they will have to pay to cover the hospital's costs is likely to be much, much higher. The zero sum logic applies if we always have all the customers and we are just trying to spread costs around, but this is not the real situation we face.

Tuesday, November 10, 2009

News today that the managers of two Bear Stearns hedge funds were found not guilty of fraud and insider trading supports the "no villains" idea.

This was a trial by jury, with normal everyday people on the jury. That they found the two not guilty is significant.

These two Bear funds that went bankrupt heralded the beginning of our credit crisis, but not enough people saw the meaning of their downfall at the time. Why? Because it simply wasn't clear that the world as we knew it was about to end...

Here is a good story from the Wall Street Journal that I found in my search for good information on who pays the "rack rate" or "list price" for health care.

I agree that it is bothersome that some of the most needy end up paying the highest prices for health care.

But at the same time, there are some good reasons for those price differences and some lessons to be learned.

How many of us ask when we go to the doctor what the price of the service will be (and how many doctors even know)? Why are we willing to accept such ignorance of prices from docs and hospitals when we will haggle to the final penny with a car dealer or a bank on a mortgage? This is just one example of the inconsistencies in people's behavior when it comes to health care vs. other products and services. Another one is that many people think regular exams and preventive maintenance should obviously be covered by insurance. I bet I could find people who would argue that, on their way to the car dealership to pay hundreds of dollars for their 50,000 mile checkup on their three year old Chevy. We accept that we have to maintain our cars, houses, and other property, but not our own bodies? Go figure.

At least larger insurance plans do some negotiating for us. It is too bad that not everybody gets the benefit of those negotiated rates -- if self employed people buy individual insurance plans and then have to pay full list prices. But again, if we take away the incentives for anyone to negotiate, what will that do to the pricing power of the suppliers and to the overall level of prices? I predict we would see even higher prices.

I believe it is also true that the great price differences we observe today in health care (list price vs. negotiated health plan rates) began when Medicare got into the market. Just an observation...

Sunday, November 08, 2009

"Reefnetter" asked a question about the justice/injustice of charging different people different prices for an important service like health care, or even basic products like food.

This does raise some interesting questions. Right now in health care, there are at least four levels of price, in order of high to low: The "rack" or "list" price; the negotiated price for insurance plans; the government/Medicare rate; and a price of zero. Who pays the rack price? Not too many people, would be my guess, but I am not sure. If you are self employed and buy health insurance in the marketplace, that policy could still have a negotiated rate with suppliers. Some people who pay the full price are actually the rich uninsured; others would be medical tourists. Who pays the "zero" price -- well, that would be the destitute who get care and cannot pay. This might also end up being a negotiated rate, greater than zero but less than maybe even the Medicare rate.

Do these price differences concern me, especially given that the well-to-do will generally receive the negotiated rates rather than the list prices? Not, not really.

One of the benefits of these price differences is that they serve to put pressure on the service providers. Suppose we had a law saying that health care providers had to charge everyone the same price. Do we think that would result in higher or lower prices overall? I am sure it would result in higher prices, because it would prevent any one insurance plan from being able to ask for and receive a lower price. It is that process of insurance plans going to service providers (e.g., large hospitals, doctors' clinics) and negotiating lower prices that gives us some relief from unmitigated price escalation. Does this process of competition mean that some plans will negotiate lower prices than other plans? Yes -- and that is exactly what we need to give the plans incentives to put pressure on the service providers. In the new world of health care about to emerge, this will be one of the main ways for different insurance plans to get a competitive advantage. We should celebrate it -- how else will we get the health care providers to put a lid on their prices?

Note also that generally the larger plans will be able to negotiate the best prices. Why? Because they will be able to promise (or withhold) large amounts of business from the providers. Bulk purchases generally do get better prices. This is true for electricity, food, cars, ....you name it. Reefnetter, I bet you give your largest customers some kind of volume discount, right? In health care, it is valuable for a hospital to be able to count on business from a large pool of insured people. This gives the hospital enough confidence in its volume to expand facilities, invest, etc.

Another side benefit of the high list prices is that it induces people into the ranks of the insured. There is a real problem in health insurance caused by people "gaming" the system: being uninsured when healthy, then getting into insurance just when you need it. This is one of the problems that the health care reform is dealing with, this time with penalties for not being insured. If the uninsured can get the same low rates as the insured, then there is even more incentive to game the system.

Interestingly, I have always thought that the lack of price differences for some goods and services has created some distortions in our society. For instance, the postal service charges the same rate for rural service as for urban service, even though the cost of rural service must be higher. Similarly, AT&T always charged the same rate for home service, no matter how few people were in an area. These prices entailed low-cost, urban customers subsidizing high-cost, rural customers -- was that fair, or good?

About Me

I was born in the Upper Peninsula of Michigan, went to Northern Michigan University undergrad and UCLA for my PhD in economics. I am the Senior Associate Dean and Professor at the Tuck School of Business at Dartmouth College. I lean libertarian, but for lack of political success on that front I tend to support the Republican Party.
The usual boilerplate applies: What I write here represents only my views, not those of my employer.